The idea of comparative advantage is not dead!

Pascal Lamy on Krugman, Samuelson and comparative advantage:

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“At the outset, let me recognize Paul Krugman’s intellectual contribution to international trade theory — the so-called “new trade theory” — in which he shows that, even in the absence of productivity differences between two countries, trade benefits them both. He focuses on the presence of increasing returns to scale, in which a firm’s average cost per unit declines as production increases and underscores that consumers value variety in consumption. While the new trade theory reduces the role played by comparative advantage, it identifies new sources of benefits from trade that were not emphasized or recognized by the classical economists. More trade benefits all countries because specialization in production reduces average cost and consumers gain access to a wider variety of products. In contrast, traditional theories of trade assume the variety of goods remains constant even after trade-opening.

 

There is a much-cited paper by Paul Samuelson in the Summer 2004 issue of the Journal of Economic Perspectives which showed theoretically how technical progress in a developing country like China had the potential to reduce the gains from trade to a developed country like the United States. This paper appeared to be a dramatic about-face against the idea that open trade based on comparative advantage is mutually beneficial.

There is a much-cited paper by Paul Samuelson in the Summer 2004 issue of the Journal of Economic Perspectives which showed theoretically how technical progress in a developing country like China had the potential to reduce the gains from trade to a developed country like the United States. This paper appeared to be a dramatic about-face against the idea that open trade based on comparative advantage is mutually beneficial.

I emphasize the word “appeared” because subsequent analysis by Jagdish Bhagwati, Arvind Panagariya, and T. N. Srinivasan contradicted this view. In that paper, starting from autarky, China and the United States open up to trade and experience the usual gains based on comparative advantage. In the following part of the paper, Samuelson considers how technological improvements in China will affect the United States. In the case where China experiences a productivity gain in its export sector, both countries benefit. China gains from the higher standard of living brought about by the increase in productivity while the United States gains from an improvement in its terms of trade. In the case where China experiences a productivity gain in its import sector, there is a narrowing of the productivity differences between the countries which reduces trade; and as trade declines, so too do the gains from trade.

So what Samuelson has showed is not that trade along lines of comparative advantage no longer produces gains for countries. Instead, what he has shown is that sometimes, a productivity gain abroad can benefit both trading countries; but at other times, a productivity gain in one country only benefits that country, while permanently reducing the gains from trade that are possible between the two countries. The reduction in benefit does not come from too much trade, but from diminishing trade. Furthermore, even in this case, Samuelson himself does not prescribe protectionism as a policy response since, as he put it ,“what a democracy tries to do in self defense may often amount to gratuitously shooting itself in the foot”.

In my view, the analysis by Bhagwati, Panagariya and Srinivasan should convince us that the principle of comparative advantage, and more generally, the principle that trade is mutually beneficial, remains valid in the 21st century.”

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Lamy attempts to debunk some fallacies in trade discussions:

• Fallacy #1: Comparative advantage does not work anymore
• Fallacy #2: It is unhealthy for trade to grow faster and faster compared to output (there is a problem with the way we interpret (and measure )volume of trade and value addition)
• Fallacy #3: Current account imbalances are a trade problem and ought to be addressed by trade policies.
• Fallacy #4: Trade destroys jobs
• Fallacy #5: Trade leads to a race to the bottom in social standards.
• Fallacy #6: Opening up trade equals deregulation

It is worth reading the full text.

Nepal-US Trade & Investment Framework Agreement (TIFA) & Exports

My latest column is about the implications of the US-Nepal TIFA. I make the point that there is little, if any, immediate gains in terms boosting exports. However, the pact is a right move in promoting Nepali exports industry and exports. A high level delegation led by Nepal’s commerce secretary was in DC. I met them twice last week.

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Nepal-US TIFA and Exports

There has been a lot of discussion about the proposed US-Nepal Trade and Investment Framework Agreement (TIFA). The Nepali delegation led by Commerce Secretary Purushottam Ojha is in Washington DC to finalize the pact, which the two countries will formally sign soon. The proposed new pact with the biggest economy in the world has reignited optimism among Nepali exporters. It is seen as a precursor to a free trade agreement (FTA) between the two countries.

Nepali investors and exporters should understand that TIFA is not a panacea for the ailing exports sector. In fact, nobody knows if the enactment of TIFA would boost exports to the US. It does not give additional tariff concessions for the beleaguered export-oriented industries, including ready-made garments. It is merely a pact that establishes a framework for enhancing trade, technical cooperation, and resolving outstanding disputes between the US and Nepal. It is not a silver bullet to regain the lost glory of Nepal’s exports to the US.

When the Nepali delegation floated the idea that Nepali ready-made garments be given the same preferential treatment that the US provides some African countries for quota and duty-free entry into the United States following the African Growth and Opportunities Act (AGOA) of 1992, the US representatives gave an apt advice: Improve domestic business environment and make it easier for the US companies that are already investing in other South Asian countries, mainly India, to invest in Nepal. Additionally, they asked the Nepali delegation to diversify exports basket. The probability of investment by a company that has experience of operating in South Asia is higher than a company that has no experience running business in the Indian sub-continent. The investors that are already investing in this region understand relevant business constraints better and, if given enough incentives, might invest in Nepal as well.

Source: USTR

Enough has been said about the demise of the garment industry in Nepal. But, no trade related discussion is complete without mentioning the downfall of this industry and its impact on the economy. Concerning the US market, the only notable item we were exporting with comparative advantage before 2005 was ready-made garments. This was possible not because our exports were price and quality competitive, but because the international market was not a level playing field for all garment exporters in the world. The end of Multi-Fiber Agreement (MFA)—which eliminated quotas on the trade of textiles and clothing— in 2005 crippled the domestic garment industry. It struggled to compete, both in terms of price and quality, with superiorly competitive garment producers from other countries. The message was loud and clear: We desperately need to enhance our competitiveness, diversify our export basket, and effectively market our goods and services abroad.

The policymakers need to realize that nothing will move forward unless there is political stability and cessation of incessant harassing of investors and entrepreneurs by militant labor unions and political youth wings. No matter how many TIFAs are inked, in the absence of security and political stability, there will be no substantial positive change in exports. The only direction exports and exports revenue can go are downward. Forget about foreign investors; even domestic investors will not invest if there is constant threat to life and private property.

To make TIFA effective, there is a need to look at binding constraints on investment and trade. Importantly, we need to upgrade technology and human capital capable of producing ‘nearby’ goods, which are in close ‘proximity’ with products that the economy is already producing. This would speed up transformation of not only the export-oriented industries but also the whole economy as rural and informal sector workers will be absorbed into the industrial and formal sectors. Furthermore, the country needs to address energy crisis and shortfall of infrastructure, which several studies have identified as the most binding constraint on Nepal’s economic growth.

Given this bitter reality, there is hardly any immediate tangible benefit out of the US-Nepal TIFA to the Nepali export-oriented industries. It does nothing except to implant optimism among investors that things are moving in the right direction and, if situation improves, trading opportunities will be much more reliable, secure and better.

What goods can we export with comparative advantage to the US market? Neither the policymakers nor the exporters have a definite answer. A comprehensive analysis of the potential for new exportable items to the US market is long overdue. In fact, a product-level and state-level analysis of the markets for Nepali goods in the US will be helpful to exporters because taste and preference of consumers in the $14 trillion economy are vastly different. The items under consideration right now are mostly a narrow set of agricultural and handicraft goods.

Not only there is a need to diversify our export basket, there is also a need to export goods that will help to increase exports revenue so that trade surplus with the US partly offsets overall trade deficit. The existing concentration of Nepal’s exports is extremely high, i e the export basket is composed of few goods upon whose international demand our export industry depends on. It is exposing the economy to greater trade and growth volatility. Studies have shown that the more diversified the export portfolio is, the lesser would be growth and export volatility. In addition, identifying and focusing on exporting goods and services that have high value-addition would mean sustainability of the export-based industries.

The US-Nepal TIFA will not provide immediate relief to Nepal’s ailing exports sector. However, this treaty is a right move in terms of smoothening and settling investment and trade issues, and enhancing trade and technical cooperation between the biggest economy in the world and the poorest country in Asia. There will not be any marked improvement in exports unless the binding constraints on investment and trade are addressed right away.

[Published in Republica, April 10, 2010, pp.6]

Doctors to the rescue in the forest…

Caption: A combo picture of a 26-year old woman in labor pain while grazing goats at a forest in Kalikastan, Achham, Nepal, and giving birth to a baby. Locals say around 50 women deliver babies in a similar circumstance in the jungle. The nearest health post is 500 meters from the forest. Only 13.3 percent of the total pregnant women go to Kalikasthan district health center for delivery.

[Source: The Kathmandu Post, 2010-4-12, pp 4]

A three-year national plan for Nepal

The National Planning Commission (NPC) has come up with an investment plan to steer the economy at a moderate growth rate (5-6%) in the next three years beginning mid-July 2010.

Here are some of the details:

• Aim to achieve GDP growth rate of 5 to 6 percent
• Lower absolute poverty to below 21 percent
• Generate 200,000 jobs
• Private sector estimated to invest 64 percent of the total estimated investment; the government will invest the rest. The service sector is expected to absorb an estimated Rs 732.17 billion, the industrial sector Rs 153 billion, and the agricultural sector Rs 133.5 billion.
• Expected size of the economy in 2013: Rs 1397.4 billion (around US$ 20 billion) at producer prices. This fiscal year it is expected to reach Rs 1176.56 billion.
• Total consumption in mid-July 2013 is expected to reach Rs 1239.5 billion (88.79 percent of the estimated GDP). Meanwhile, total investment is expected to reach Rs 359.3 billion.
• Estimated total revenue mobilization: Rs 678 billion (17.4 percent of estimated GDP)
• Estimated government capital expenditure: 9.1 percent of estimated GDP
• Estimated internal loan: 2.1 percent of estimated GDP
• Sub-sector wise, transport, storage and communication is getting Rs 223 billion while agricultural and forestry sector is getting Rs 130 billion.

Few preliminary comments by just reading the news (I have not read the official document and looked at the estimates!):

• It is encouraging to see that the infrastructure sector is getting the most priority. It has been identified as the most binding constraint on Nepal’s economic growth. But, where is the investment in generating electricity?
• Generating an estimated 200,000 jobs will be a challenge, unless this one is temporary target.
• How are we going to channel remittances, which amount to approximately 20 percent of GDP, in the domestic (productive) sectors? Most of the remittances are either going to the real estate market or being driven to India (through increasing consumption of Indian goods and services, thus contributing to ballooning trade deficit with India)
• How will this plan help to remedy the most pressing macroeconomic challenges and macroeconomic paradoxes in the Nepali economy?
• Investment alone does not increase employment. There could be job less growth, fuelled by over-investment in few sectors such as real estate. In fact, with substantial leakages and weak institutions, the growth rate might not be as expected even if there is increasing ‘investment’ in the form of money being channeled to the specified purposes.
• What will happen to macroeconomic balance (fiscal and monetary)? How will the central bank react to rise in general price level (demand side effect coming from the injecting of new investment money and supply side effect coming from supply bottlenecks, deficit production and imports from India)?

Africa is growing...

Source: WDI 2009

Note that we need to differentiate between oil exporting countries and non-oil exporting countries. Most of the high performers in Africa are oil exporting countries.

A chart disaggregated by oil-exporting and non-oil exporting countries with population share in Africa is below:

RCTs to measures the effect of menstruation on girls education in Nepal

Thornton and Oster, did a randomized controlled trial about the relationship between menstruation and attendance of girls in school in southern Nepal. Their finding is surprising: only about a third of a
day per year is missed due to girls’ period. The allocation of menstrual cups to girls has no effect on scores. Girls not allocated menstrual cups in the initial randomization were 2.6 percentage points less likely to be in school on days they were menstruating. This falls well below the 10-20% estimates made by policy makers.

Researchers randomly selected half of the girls in our sample and provided them with a menstruation cup to replace the cloths they had been using. They compared the increase in attendance rates on period days for girls with and without this improved sanitary protection and found no impact: both groups missed slightly more school on days with their period.

Does this mean that sanitary-related intervention is not worthwhile? They say No!

It is important to note that this does not imply that there are no benefits to better sanitary products. Girls in the study were very happy to have the menstrual cup: it limited the amount of time they spent doing laundry, and the majority of girls used the menstrual cup regularly and would recommend it to their friends. The bottom line is while policies to provide better sanitary products in the developing world may have positive value, we should not expect them to impact schooling.

Here is a related paper by the same authors on peer effects on menstrual cup take-up.

We estimate the role of peer effects in technology adoption using data from a randomized distribution of menstrual cups in Nepal. Using individual randomization, we estimate causal effects of peer exposure on adoption. We find strong evidence of peer effects: two months after distribution, one additional friend with access to the menstrual cup increases usage by 18.6 percentage points. Using the fact that we observe both trial and usage of the product over time, we examine the mechanisms driving peer effects. Our results suggest that successful uses by peers are more important than peer unsuccessful usage attempts. In addition, we argue that peers matter because individuals learn how to use the technology from their friends, but that peers do not a effect an individual's desire to use or attempt to use.

Can Africa meet the MDGs target by 2015?

In 2001, all 192 United Nations member states agreed to a set of eight international development goals to be achieved by 2015. With only five years to go before the deadline, only a third of those targets have been reached. Most countries are not expected to meet the Millennium Development Goals (MDGs) target in time. What is going on with MDGs and why Africa is lagging behind? Can Africa really meet the MDG targets by 2015?

 

There questions were discussed at an event in Carnegie Endowment last week, Jan Vandemoortele, a former UN staff member and co-architect of the MDGs, highlighted the progress made so far at the global level. Shanta Devarajan, chief economist of the World Bank’s Africa Region, focused on the progress so far in Africa toward achieving the MDGs. Selim Jahan, director of Poverty Division at UNDP, discussed the successful policy interventions that could assist countries in achieving the MDGs target by 2015. Carnegie’s Eduardo Zepeda moderated the event.

Regional vs Global Progress

The Millennium Development Goals are, by their nature, collective goals applied in a broad global canvas. The targets themselves are set by extrapolating global trends through 1990. The panelists agreed that applying the targets to individual regions can be problematic:

• Since the MDG targets for 2015 are extrapolated from global trends, it is incorrect to look at a single region, such as Africa, and say that they are off-track for the 2015 targets, argued Vandemoortele. MDGs are collective global targets. They are not targets for Africa only. It is the international community missing the point, insisted Vandermoortele.
• The MDG targets set a bar particularly difficult to achieve for African nations, which started the twenty-first century at very low development levels, Vandermoortele reminded the panel.
• Jahan agreed that vast disparities in the regional and national levels require a consideration of the MDG targets that goes beyond global averages. With only five years remaining to meet the MDG targets, he suggested that an analysis of proven interventions that could be scaled up and replicated in the regions that are lagging could help accelerate progress.

From a global perspective, the world is on track to achieve the income poverty targets, mainly due to massive poverty reduction in China. However, Devarajan pointed out, global progress does not mean that Africa is equally on track to achieve the targets.

 

The Pattern of Progress

Panelists discussed some of the factors contributing to slow progress toward the MDG targets in Africa, including inequality, structural constraints, and unemployment:

• Increasing economic inequality in African nations has meant that when progress toward the MDG targets has yielded tangible benefits, those benefits have bypassed the poorest citizens who need them the most. Vandermoortele pointed out that there is evidence that in a more economically equal society, fewer people live in poverty and there are fewer health and social problems. An increase in social inequality will thus impede progress toward achieving the MDGs.
• To sustain the progress made so far, it is necessary to address the social, political, and economic constraints that are hindering sustained economic growth, increase in trade, and improvement in human development, said Jahan. He suggested the implementation of a comprehensive, integrated reform package to deal with all facets of the existing constraints. He also suggested using models from other successful southern hemisphere development initiatives to help African nations move forward on the MDGs. 
• Jahan argued that employment creation could be the missing link between economic growth and poverty reduction. “For a long time, we depended on growth-led employment generation, which basically turned out to be jobless growth. Can we have employment-led growth?” he wondered.

Africa and the Global Economic Crisis

 

The global economic crisis has slowed down and perhaps even reversed the progress made towards the MDGs. “Fortunately, the timely and appropriate responses of African policymakers have helped dampen the impact and set the stage for the continent to benefit from a global recovery,” argued Devarajan. He contended that Africa’s rapid growth since 1995, improvements in service delivery, and better policies have changed the MDG outlook for Africa.  Africa can meet the MDGs, “if not by 2015 then soon thereafter,” he concluded.

Aid Effectiveness and International Financial Institutions

Panelists discussed the effectiveness of international aid and international financial institutions in making significant and long-lasting progress toward achieving the MDG targets.

• Jahan argued that a multi-pronged strategy and multi-actor involvement is necessary to enable international development aid to contribute to progress on the MDGs. He suggested that international financial institutions have three crucial roles they can play:
  1. They can play a positive role in international development by speeding up the process of meeting development goals. 
  2. They can bring outside knowledge and expertise to developing countries; 
  3. They can effectively deal with global constraints related to a country’s growth such as international trade, innovation, and acquisition and use of new technology.
• Vandermoortele stated that sustainability depends on achieving a deep transformation at the local level. International donors and financial institutions cannot create local change, and there is a risk that international involvement will keep the MDGs from the grassroots effect they are intended to have.

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[Btw, the event was organized by TED program and, yours truly, noted the main points!]